Wednesday, January 27, 2010

Show The Buybacks, Ignore The Options

Hartco (HCI) is an IT solutions company servicing the private and public sectors. The company appears to offer some value potential at its current price, with a market cap of $50 million, which is not much more than its net current asset value, and earnings of almost $2 million in its last quarter.

The company is up to some interesting tricks, however. Two days before its 3rd quarter began, the company announced that it may buy back up to 5% of its common stock in the coming year. But this appeared to be nothing more than a public relations move: in the third quarter, the company ended up buying back just 22,000 shares. At the same time, it issued 987,668 options to executives and directors!

Issuing options is nothing new of course, but what is worrisome is that the company only has 13.6 million shares outstanding, yet in a single quarter it issued 7% of that number in stock options! Equally worrisome is how the company talks up its buybacks in the headlines, while quietly issuing this egregious number of options in the background. The company used this line in its top paragraph on "business priorities" to talk up its paltry purchase of 22,000 shares, while it made no effort to explain the unusually large issuance of options:

"At September 30, 2009 the Company had repurchased 22,000 shares at an average price of $ 2.18 per share for a total of $ 48,000. The Board of directors of Hartco considers that the [buyback] is an appropriate use of financial resources and will be beneficial to Hartco."

Management will often headline the items that are likely to appease shareholders. However, the onus is on investors to dig deeper in order to figure out what the company is really up to.

Disclosure: None


Ankit Gupta said...

Were the options priced at/near current market value or something that requires the stock to move up in value by a large amount?

When companies issue lots of stock at multiples of what it's trading at, I actually like that. If the stock really can move up to multiples of its current value, I'd like to see management have an incentive to get it there even if it means 4-5% dilution.

I follow a company where I know there will be probably 5% dilution if the stock doubles in price, and that's an amount I'm very happy with.

Saj Karsan said...

Hi Ankit,

Most options are granted with strike prices pretty close to current prices. While incentives are good, be careful of the incentive that is implicit in an option that is way out of the money: management has no downside, but high upside, so they may take unusually high risks, as they don't share the downside with shareholders. Some argue that this was a big contributor to the Lehman Brothers bankruptcy.